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Sunday, November 2, 2014

Seven Deadly Investment Mistakes… Watch Out!!

Ok, the title sounds a little crazy or even scary but, hang on with me here. By the end of this article you will know exactly why this article is titled so…

The main reason we invest is to make more money. As simple as that. Right?

Did you know that on an average the rich investor makes a lot more money than the normal or common-man investor. Without talking about numbers, just taking the % returns into consideration, the rich investor easily makes about 5-10% or more returns than a regular investor (whose main aim is to one day become rich). So, how come they make much more profits than us?

If you say, the amount they invest, go back and read this previous paragraph, we are talking % returns here and not absolute returns. Now, think why!!!

They don’t make the common Investment Mistakes that we so easily make. In fact, most of us don’t even realize that we are making this mistake. Anyways, for the rich folk, their investments are handled by professional investment managers (Privileges of Private Banking) and they make sure not to commit these mistakes. Enough of the pep-talk, lets get down to business…

Deadly Mistake No. 1: Portfolio Over-Diversification

Have you ever heard of the old saying “Don’t put all your Eggs in the same basket”? The purpose of Portfolio Diversification is to ensure that we invest across asset classes and don’t stick to a single basket. But, an over-ambitious investor usually ends up over-diversifying his/her portfolio by choosing too many investments.

Let me give you a simple example. One of our blog readers had emailed me asking if his mutual fund portfolio is good. He was investing Rs. 2000/- as SIP Across about 15 funds. Yes, 15 funds. He was investing 30,000 rupees each month which is sizable investment but if you take a step back – 15 funds make his portfolio over-diversified and very hard to manage. Do you honestly think someone can track the performance of all those 15 funds? We can actually reword Portfolio Over-Diversification as Portfolio Over-Diworsification.

I suggested that he select 3-4 good funds across various categories like Large Cap, Diversified Equity, Mid-Cap and Small-Cap and invest the money according to his risk appetite.

Deadly Mistake No. 2: Over Emphasis on Past or Historic Returns

Have you seen any mutual fund prospectus or advertisement? There is usually a * which says “Past Performance may or may not be sustained in future”. This is because, no one can guarantee the fund returns and even though a fund may have given extra-ordinary returns in the past one or two years, the same may not be possible in future. Unfortunately, most of us go by past returns and end up expecting unreasonable returns.

Be realistic – just because a fund gave 40% or 50% returns during a bull market, it does not mean that the fund will continue when the market makes a U Turn…

Deadly Mistake No. 3: Investing Without a Plan

When was the last time you sat down with a pen and paper to analyze a potential investment before you actually put your money in it? Most of us consider Investment as a one-time activity and don’t really put much emphasis on planning.

You must create a disciplined plan based on mathematical expectancy because anything less is gambling and not investing. Never gamble on rumors, hot tips, stories, future predictions, or an expectation the market will go up. None of these approaches qualifies as a plan despite their widespread use and popular appeal.

Deadly Mistake No. 4: Trusting Experts Blindly

This is by far the most common and prevailing mistake that almost 99% of investors do. Yes, an expert is someone who knows more about investment, stock markets or any other subject than you. But, does he know more about your personal situation than you? Does he care more about your financial future than you? Would he share your losses if you end up incurring some along with you?

The answer to these Questions would be a Big No. On top of all this, this so called expert or financial advisor is getting paid to sell investment products to you. So, do you really want to blindly trust such a person?

The bottom line is your investment advice is coming from sources whose business objectives are focused on their wealth, not yours. Don’t make the mistake of trusting the experts. You should always operate from the assumption that the investment advice you receive is tainted. We all have biases including you and me.

With that being said, I also believe there are many honest, good people doing their absolute best to work with the limited knowledge and conflicting data that make up the investment world. But, we are all human and may make a mistake as easily as anyone else.

Any investment portfolio must have a combination of instruments that range from fully safe options like Fixed Deposits to risk options like Equity Stocks or Mutual Funds. Excessive exposure to risky choices may result in huge losses and similarly excessive exposure to safe investments may result in low returns. I wrote an article a few weeks back titled “Does My Portfolio Need Equity Investments?” which actually explains why you should diversify across asset classes…

Deadly Mistake No. 6: Holding on to a Loser – In the Hope of Breaking Even

Sometimes, even the best investor makes bad choices. It is all part of the game. A smart investor is one who can own-up to his/her mistake and sell an investment (even if it means incurring a loss) if it was a bad decision. Many of us hold on to such loser stocks or mutual funds in our portfolio in the hope that someday this investment will break-even and you can at least recover whatever you invested. What makes things worse is that, some of us may even end up buying more of this loser to average out our losses.

If you take a step back and think why we do this – the answer is very simple. Not everyone can accept that they were wrong. A smart investor is one who can actually accept that fact that he/she did a mistake because it is perfectly fine to make a mistake. Holding on to the loser is actually a bigger mistake than actually owning up to our mistake and moving on…

Deadly Mistake No. 7: Mixing Emotions and Investments

Have you ever heard of the saying “Water and Oil – Do Not Mix”? Emotions and Investments are almost the same. Yes, investment is something we must make with our brains and not our hearts. Sometimes our emotions may interfere with our ability to make prudent decisions. So, if you are going through emotional duress (like loss of a loved one) or are basing an investment decision based on emotional motivation (like recommendation by a family member/relative), there is a very high probability that this investment will end up being a loser.

Never, mix your emotions with investments. Invest only when you are calm and clear.

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